What Does an Interest Rate Cut Mean to You?

Financial contributor Mellody Hobson answers questions about Fed meeting.

ByABC News via GMA logo
February 12, 2009, 10:49 AM

Sept. 18, 2007 — -- "Good Morning America" financial contributor Mellody Hobson answers some frequently asked questions about what today's meeting of the Federal Reserve board means to consumers.

It seems as if the general consensus is the Fed will make a cut in interest rates at its meeting today, but by how much is up for debate. What do you think will happen?

While some are anticipating a cut of 0.5 percent, I'm leaning more conservatively and believe we will see a rate cut of 0.25 percent, which would bring the fed funds rate down to 5 percent from 5.25 percent. Assuming there is a rate cut, it will represent the first cut since June 2006, or the first time the Fed has lowered rates in 17 consecutive quarters.

What is the basis for the Fed potentially lowering the fed funds rate?

The weakening job market propelled by steep declines in construction and manufacturing payrolls coupled with the housing market slump and the associated subprime mortgage crisis and credit crunch, suggests recessionary conditions might be lurking, which is spurring the Fed to take action to ensure continued economic growth.

Keep in mind, the fed funds rate is a key short-term interest rate that impacts consumer loans. Ultimately, by lowering the rate, the Fed would be making it less expensive for consumers to borrow money, which could, in turn, encourage continued spending, thereby stimulating the economy.

What about the stock market? Will the recent volatility influence the Fed?

Not directly. Remember, the purpose of the Fed is not to bail out investors in times of market turmoil. Rather, the Fed's mandate is to set monetary policy. Simply put, the goal of the Fed is to promote economic growth by keeping unemployment low and inflation stable.

And what does this mean for consumers? Will it help us get a handle on our mortgages and our credit card debt?

The bottom line is, lower interest rates are a good thing for consumers. While the Fed does not directly control mortgage rates or interest rates on credit cards, it does have an indirect impact on these rates. Credit card interest rates will dip slightly, as will auto loans and, even, mortgages.

Homeowners with adjustable rate mortgages could see their rate reset at a lower amount, which is good news. However, the cut would not have a meaningful impact for consumers. The typical credit card holder could see their monthly payment drop only a couple of dollars, and homeowners could see mortgage rates dip slightly.

What is your outlook for the market? Also, do you think further cuts to the fed funds rate are on the horizon?

Regardless of the outcome of [today's] meeting, I think we will continue to see choppy waters in the stock market. Additional fallout from the subprime crisis is likely, and its full impact on the economy is unknown at this point. And, as I have said before, the market hates uncertainty, and these would definitely qualify as uncertain times.

In terms of future rate cuts, the Fed meets again at the end of October, and then one last time before year-end, in mid-December. Only the 12 members of the Federal Open Market Committee know for sure what will happen, but if I had to venture an educated guess, I would say that additional rate cuts are likely through the end of this year.

Mellody Hobson, president of Ariel Capital Management in Chicago (www.arielmutualfunds.com), is "Good Morning America's" personal finance expert.